Australia's government abandoned a long-held pledge to return its budget to surplus, blaming a painfully high local currency, lower export earnings and lower company profits for blowing a massive hole in tax takings.
Treasurer Wayne Swan said cutting spending further to achieve its pledge of a small surplus in the fiscal year to end June 2013 would threaten economic growth and be "self-defeating".
"Dramatically lower tax revenue now makes it unlikely that there will be a surplus in 2012-13," Swan told reporters in Canberra on Thursday, adding that revenue in the July-October period was A$3.9 billion ($4.1 billion) lower than had been forecast.
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"At this stage I don't think it would be responsible to cut harder or further in 2012-13 to fill the hole in the tax system, if that puts jobs or growth at risk," he said.
Swan's comments will be a major blow to the Labor minority government, well behind in opinion polls and due to face elections in the second half of 2013. It has long promised to deliver a surplus in the year ending June 30, 2013.
Labor was first elected in late 2007 with a promises to deliver budget surpluses, but Swan pushed the budget into deficit to fund massive stimulus spending to help the economy avoid recession following the 2008 global financial crisis.
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But with signs that Australia's mining boom has peaked, falling prices for iron ore and coal, and with a new tax on iron ore and coal mine profits generating less revenue than forecast in the first quarter, the surplus budget has been increasingly difficult to deliver.
Ratings agency Standard & Poor's said the shift from a small surplus to a small deficit would not hurt Australia's AAA credit rating and financial markets were unaffected by Thursday's decision.
"The government has bowed to grim reality and done the inevitable," said Commonwealth Bank of Australia chief economist Michael Blythe. "Fiscal policy is still being tightened. It just wasn't sensible to go even further with many parts of the economy subdued," he said.
Blythe added that the outlook for the budget was still favorable by international standards, with his models currently showing a likely deficit of only around A$1.6 billion for 2012/13.
"There are plenty of rich countries with much worse budget outlooks," he said, adding this was one reason Australia's triple-A credit rating should not be threatened by the change.
Swan said the economy remained strong but was facing a set of unusual circumstances driven by global developments that had slowed economic growth, lowered commodity prices and kept the Australian dollar stubbornly high.
Usually when prices fall for key Australian commodities such as iron ore and coal, the local currency does as well and provides an offsetting stimulus to the economy.
This time, the Australian dollar has defied all the headwinds and held firm above parity against its U.S. counterpart. On Thursday, it was at $1.0470, actually higher than where it started 2012, at $1.0220.
Australia was one of the few developed nations to have forecast a budget surplus for the current year. The government had in October revised down the expected surplus to A$1.1 billion, from May's budget forecast of A$1.5 billion.
Investors, however, have suspected for some time that a surplus would not be achievable for 2012/13 and there was no sign of selling pressure on government bonds on Swan's statement. Yields on 10-year government bonds were a shade lower on the day at 3.36 percent.
JPMorgan economist Tom Kennedy said the move would ease pressure on the Reserve Bank of Australia (RBA), which has cut its cash rate by 175 basis points over the past year or so, taking it to a record-matching low of 3.0 percent.
Markets are still pricing in a 60 percent chance of a follow-up cut in February, when the RBA next meets.
"At this stage, it takes a little bit of the pressure off the RBA. The fiscal drag from tighter government spending is going to be less and for that reason, the RBA potentially has less work to do," Kennedy said.
Opposition leader Tony Abbott said Prime Minister Julia Gillard had now abandoned a pre-2010 election promise that the government would deliver a surplus budget.
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"What this demonstrates is you just can't trust this government to manage the economy," Abbott told reporters in Sydney. Monash university political analyst Nick Economou said the government had no choice but to abandon the surplus pledge, as it could not afford to go into an election year needing to cut more spending programs.
"The government has no choice. It can't make vicious cuts to programs in an election year. It just can't be done," Economou told Reuters, adding the government could now have some freedom to spend more on pre-election sweeteners.
Swan, however, stressed that the government was still running a tight fiscal policy, telling reporters he would not be loosening the purse strings.